As Fed speaks more clearly, what will markets hear?

The Federal Reserve's latest push toward increased transparency has so far done more to muddle the outlook for interest rates than clarify it.

The historic decision to begin publishing the interest rate forecasts of individual central bank officials after a meeting next week has increased the guesswork for economists and investors.

Not only must analysts figure out what the Fed might be thinking, but also how the market will react.

The forecasts may be a good thing insofar as they give financial markets and the public a fuller picture of what the policysetting Federal Open Market Committee is thinking.

The more transparency the better, said Charles Frank, a portfolio manager at Stewart Capital Advisors.

Still, for anyone hoping the projections could give the economy a lift by pushing back market expectations of when rates will move higher -- a step that would push current borrowing costs lower -- the shifting landscape might prove problematic.

The core of the FOMC would like to find a way to provide more monetary stimulus, and sees enhanced communication as a tool to provide such stimulus, said David Resler, an `economist at Nomura.

However, we believe that these new disclosures are unlikely to have as significant an impact on financial markets as the change introduced in August, he said, referring to the Fed's promise to keep rates exceptionally low until at least mid-2013.

After pushing overnight rates to near zero and buying $2.3 trillion in bonds, the central bank employed communications as a new front to ease financial conditions further.

Now, it's gearing up for an even bigger shift in how it communicates on policy, the latest in a series of transparency steps initiated by Fed Chairman Ben Bernanke.

UNINTENDED CONSEQUENCES?

After its first policy meeting of 2012 on Tuesday and Wednesday of next week, the Fed will publish policymakers' individual forecasts for the path of overnight rates, including their views on when the first rate hike will come.

The central bank could also announce an explicit inflation target, probably of around 2 percent or a bit below, as a way to further anchor the public's expectations for price increases, which economists say tend to be self-fulfilling.

Resler said such changes will mark a watershed moment in the Fed's approach, though any immediate impact will be muted.

Even if the forecasts show most officials now do not see rates rising until well into 2014, as Resler expects, he thinks the markets will yawn.

In a recent analysis, economists at Goldman Sachs came to much the same conclusion.

Using the so-called Taylor rule of monetary policy governing the relationship between economic slack and inflation, they extrapolated officials' likely rate expectations from their existing estimates for employment, growth and inflation.

What they found was that markets have already priced in a longer period of ultra-low rates than will likely be reflected in the Fed's new central tendency forecasts, which exclude outliers. For that reason, they worry publishing the projections could lead to an unintended tightening of policy.

(Our) estimates point to the danger that financial conditions could tighten with the publication of such forecast ranges, as the market is currently pricing only around 75 basis points of rate hikes by the end of 2014, the Goldman economists wrote in a research note.

However, they added that such a potential tightening will likely be offset by the fuller range of forecasts, which will also reflect the more dovish views of certain regional Fed presidents.

THE CAVEAT OF CONDITIONALITY

A tightening propensity might also be thwarted by a new statement on the central bank's long-term policy goals, which could hint at the possibility of a further round of bond purchases to drive borrowing costs lower.

Fed officials debated such a statement, which is likely to contain a formal inflation target, at their last meeting in December, and are scheduled to discuss a revised version next week.

Disagreement among policymakers about the function of communications has made divining the likely impact of the Fed's actions more difficult.

At the more hawkish end of the spectrum, Philadelphia Federal Reserve Bank President Charles Plosser, a member of the central bank's communications subcommittee, says the goal of clarity on the expected path of rates is simply greater transparency.

Yet more dovish regional Fed bank presidents, like Charles Evans of Chicago, see the step as a way to anchor inflation expectations and provide scope for the Fed take additional aggressive unconventional action to spur stronger growth.

One key concern about greater transparency during the tenure of former Fed chairman Alan Greenspan was that it would hinder the central bank's flexibility. Greenspan worried investors would mistake forecasts for targets, and that any shift in course might hinder the Fed's credibility.

But Frank, of Stewart Capital, says this is not a major issue for financial markets.

They're still going to be impacted by the data and will be able to adapt if conditions change, he said.